This Week in Food and Restaurants
by Aristotle Munarriz (TMF Edible)

Miami, FL (June 26, 1997) -- What if I began every stock report with a question? Would you read on to find the answer? It's July. Almost. And that can only mean yet another edition of The Edible Eight. Really. You look pretty anxious, with tanning butter in one hand, sand castle dreams in the other. So, let's cut to the chase.

1. RAINFOREST CAFE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RAIN)") else Response.Write("(Nasdaq: RAIN)") end if %> -- How many concepts do you know grew their units by 25% last month? With openings at South Coast Plaza in Costa Mesa, California, and their first international unit opening in the popular Picadilly Square area of London, it now makes a family of eight.

Of course, just because Rainforest Cafe stamps a passport and crosses the Atlantic is not reason alone to phone in your buy orders. Or your sell orders. The restaurant is a licensed unit and Rainforest will make about $700,000 a year in royalties. This is the first of more than 20 units overseas agreed to with four different foreign operators. Oh, they also have a 20% ownership stake in that particular eatery. Still, it's conceivable that once the contracted units are up they can represent about $15 million a year in franchise revenues with very little overhead.

But why worry about that, which on a per share basis would be more than the $0.78 the company is projected to make this year (before taxes and expenses)? There are still 15 more domestic units which are slated to go up in the next year and a half. These of the fully owned, $3 million in cash flow per, variety.

Maybe some were surprised two weeks ago when the company impressed analysts at a Piper Jaffray conference and showed comfort in estimates all the way up to next year's $1.22 benchmark. Why not? They've been beating them since last summer.

Back at May's annual meeting even shareholders were surprised to learn that the company's fourth unit, at Walt Disney World, was on track to surpass $30 million in its first year. Despite the recent strength in the stock, it seems the company still has the ability to surprise, like the awed diners walking into a Cafe for the first time.

2. APPLE SOUTH <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: APSO)") else Response.Write("(Nasdaq: APSO)") end if %> -- Is this a Sir Isaac Newton punchline? As the largest franchisee of Applebee's, so large that they lapped their parent company in revenues two years ago, life was good. With 70% of the growing casual dining chain's existing units it was smooth sailing. Then Apple South began to ponder what life could be like on the other side of the fence. No hand-holding, no concept spoonfed, but potentially more lucrative.

They wanted their own vehicles so they began to buy up strong concepts. Their first was of publicly traded DF&R Restaurants which landed the company the Don Pablo and Harrigan's chains. This year they have swallowed three outstanding eateries, none with more than two dozen outlets. From seafood (McCormick & Schmick) to brew (Hops) to themed (the Southwestern-themed Canyon Cafe) this has become yet another collection of solid microconcepts unproven on a national level.

The last acquisition prompted Smith Barney to downgrade the stock but that is a bit hard to justify. Canyon Cafe was just named one of 1997's Hot Concepts by Nation's Restaurant News. It's a winner. It will be a bigger winner now that Apple South has it under its wing.

Let's face it, for the last few years it's been hard to go public as a young restaurant. The sentiment is hungrier for semi chips than potato chips and the fact that going public is a dangerous option has prompted many successful concepts to find a suitor. While they sacrifice the IPO premium they latch on to a solid company with solid financials.

Few chains have taken on this opportunity like Apple South, a half-dozen concepts strong in the process. Buy low sell high? Restaurant stocks are beginning to heat up again and while Apple South shocked Wall Street last fall things have been going fairly well recently.

The $0.95 earnings estimate for this year, and $1.20 next year shows a company milking their growth curve. Trading at 12 times 1998 estimates is a bit of a stretch considering that each of their acquisitions, in a kinder market today, would easily be priced at twice that. That is actually lower than Applebee's valuation and they don't have the rich concept pipeline. And, that's even beyond the consideration that Applebee's is fairly thin now as well.

3. ROCK BOTTOM RESTAURANTS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BREW)") else Response.Write("(Nasdaq: BREW)") end if %> -- Truth in advertising? Check the stock name. Check the stock price. Why is Rock Bottom still trading at rock bottom prices? As the company continues to grow its Old Chicago and Rock Bottom Brewery concepts, now past 60 units, the company has continued to make headway in improving their operations.

While the stock has been flatter than yesterday's brew the solid revenue growth, which never really left, is now being met with strong earnings growth as margins continue to improve. Still, investor sentiment is running a bit barley sour over both restaurants and microbrew stocks. You can blame them for staggering about, but don't call for the tab or the cab just yet.

Two months ago the company reported its fiscal first quarter, which were sober and spectacular. While the bottom line, $0.11 vs. $0.08 a share for the quarter was nice, there was plenty of body beneath the suds. Margins, which had been responsible for the downdraft, rose. While sales rose just 39%, net income actually climbed 48% higher. Cash flow improved to 17.5% and comparable restaurant sales rose 2%. That should have been plenty to send the shares higher but it did not. In the meantime the $8.25 book value highlights an attractive balance sheet that is heavy on assets and low on liabilities. So, let the tab seekers go, it only leaves some empty bar stools for the bottom feeders.

4. BERTUCCI'S <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BERT)") else Response.Write("(Nasdaq: BERT)") end if %> -- What if I were to tell you that Jerry Crugnale is a charismatic genius? What if I were to tell you that Bertucci's is beating analyst estimates, showing strong unit economics and is poised to be one of the best growth stories in the restaurant sector? Playing along so far. Okay, what if I were to tell you that this is not 1993?

Back then Crugnale's company was a Wall Street darling. It peaked above $25 a share and then, like an overbaked pasta dish, it overheated and burned out. They were growing too fast for their own good. As adept as they were at running their eateries when the time came to live up to investor expectations they took the easy money and ramped up their opening schedule. Margins contracted. Supervision was as low as turnover was high. The only sound louder than quality managers bailing was that of investors stomping over each other heading to the exits.

History lesson learned. Long-forgotten by Wall Street they began to assess the mess. Incentive programs were established to keep turnover low. The menu was enhanced with items like casseroles to win back diners, who never really wandered that far anyway. And the 80-unit restaurant chain slowed down their expansion to less than 10%.

The plan has worked. They have retained their workers, same store sales have been up over the last three quarters, and the one analyst still around is finding earnings coming in well above the expectation.

Like the go-go days of 1993, the company has reported two sound trashings of estimates and hopes are being revised upward. But it's a table for one. And while the 1997 projections have been raised to $0.47 next year is still frozen at $0.55.

One may wonder, if Bertucci's is only going to open seven new units this year how will the company grow earnings? Continued margin improvement, which while have come a long way yet still have a long way to go. But if analysts need something new to win them back then maybe it's their new upscale concept, Sal & Vinnie's Steakhouse.

In the Bertucci's AOL message board, after their last great quarterly report in mid-May, I wrote:

"Another excellent earnings report for Bertucci's this morning as they reported earnings of $0.11 vs. $0.06. Again, the only analyst releasing estimates for BERT was at $.09. This was after raising his estimates after the previous quarter. After the 1996's 4th quarter was a blowout $0.14 the analyst upped his 1997 estimate from $0.35 to $0.45. Well, guess, what, still short. Look for this figure to be upped to $0.50 soon.

As for the comments of Sal & Vinnie's and the effect on the stock. Yes, it's just one unit in Norwood, vs. 80 Bertucci's. If it pans out there should be more but not until next year. Since these are high volume eateries a few Sal & Vinnie's can have a material effect on the bottom line. But in the mean time it is comforting to know that the flagship chain continues to perform above expectations (and with positive same store sales to boot)."

Sal & Vinnie's has performed above expectations, according to Bertucci's CFO. But, then again, it seems the same can be said of the flagship concept. With tables waiting for analysts to return. This time, with an eye on the brick oven, and padded carpeting by the entrance, not the exit.

5. QUALITY DINING <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QDIN)") else Response.Write("(Nasdaq: QDIN)") end if %> -- In hindsight, shorting EINSTEIN/NOAH BAGELS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ENBX)") else Response.Write("(Nasdaq: ENBX)") end if %> was a pretty suave move late last year, right? However, going long Quality Dining as a hedge has been a disaster. Earlier this week they finally took the $200 million charge for their Bruegger's Bagels mistake. Even though the acquisition of the country's largest bagel chain once helped move the stock as high as $39 1/2, it's been all downhill. Dough begone!

It's been a mess, but why is the stock still on this list? Because the only thing travelling faster than the bad news from Quality is its share price. I mean, we are 0 for 7 here! The stock has fallen every single month since landing on our December list and that is certainly not something that is easy to do. It takes talent.

Let's look at QDIN's valuation at $5 a share, where it is currently perched, and dig into why it should rise this month. Unlike last month. Or the one before that. Or so on.

The charge is now taken. In the immortal words of The Lion King's Rafiki, when a maturing Simba questions why the baboon whacked him, "It doesn't matter. It's in the past." So, Quality has definitely taken their lumps and Bruegger's will soon be in the past. The largest critics of Quality Dining's management of the bakery were the two founders of the concept who were sitting pretty on the Quality Dining board with a 25% stake in the company.

The Bruegger creators were quick to poison the minds of their franchisees about the incompetence at Quality Dining. Funny thing is that it seems that Quality was so bad that not only did Bruegger's falter, but so did every other publicly-traded bagel company. Shares of companies like Einstein and MANHATTAN BAGELS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BGLS)") else Response.Write("(Nasdaq: BGLS)") end if %> have been pre-sliced in half.

So it's time to recognize that it was probably the entire sector, and not any one company's ability to manage, that deserves the blame. Beyond that Quality Dining is left with a solid portfolio of Burger King and Chili's franchises and company-owned concepts Grady's, Spageddies & Papa Vino. It was this same lot that had shares of the company selling for more than $20 a share.

Granted, because of the Bruegger's deal the number of shares outstanding have almost doubled. Still, even if one were to account for that, the company should still be worth at least $10 a share even if they have to give Bruegger's away.

But they won't.. And they shouldn't. Einstein is selling for what would be $25 a share of Quality Dining. Bruegger's has similar unit economics and is a larger chain. They won't get Einstein currency but there should be some money to help either shore up their balance sheet (which is necessary) or expand their existing portfolio (which would be nice).

The thing is, right now the company is valued at just a little more than what they paid BRINKER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EAT)") else Response.Write("(NYSE: EAT)") end if %> for the Grady's and Spageddies restaurants. Is Quality Dining just a bad buyer, paying the price of venturing beyond their safe franchising efforts? Or are jaded investors simply bad sellers?

The estimates from the four bearish analysts are all over the map here. Next year they are as far apart as $0.30 on the low end and $0.75 on the high end. Or a P/E anywhere from 7 to 17. Not too shabby, and that's from a camp that is understandably bearish. When the company goes back to basics, as it appears they will, maybe the horns will grow back on the analysts. But this month would be nice.

6. COCA COLA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KO)") else Response.Write("(NYSE: KO)") end if %> *** SHORT *** -- If "Coke is It" then what is this? You see, Surge is their new soft drink, not a mandate for a stock to defy gravity. Is the world's most recognized brand name worth its $170 billion market capitalization? Let's see, fizz tickles the nose but eventually goes flat right? The big K-O is not a one-product company but few even know that the comany is also behind names like Minute Maid or Sprite because its addictive cola syrup has coated the world many times over. In a volatile market people find safety in the blue chips and this has been a shelter to the point that it now trades at 44 times trailing earnings. I'm not much for rear view mirror investing so let's put this another way. Coke is trading at more than 40 times 1997 projected earnings and 35 times 1998 estimates. For a mature company growing at an annual rate half that is there room for more or is this Helter Shelter?

This is not to belittle Coca Cola and probably the most talented CEO to grace corporate culture. They have demolished their competitors and created loyalty to an almost generic product. Yes, they are in the marketing business and nobody does it better, with soda coming a distant second. The fact is that so many people have flocked to Coca Cola, unaware that the ticker symbol is the boxing term for knockout, that the assumption that this was an all-weather stock might very well begin to show leaks in the roof in the near future. The stock deserves a premium to its growth rate, possibly as high as 20 times 1998's estimate, which would put the stock at $40 a share.

Yet, sitting here in the cheap seats, where is the upside? Over time, yes, ten, maybe five years from now, Coca Cola will be higher and a true long-term investor should probably make out fine, despite underperforming the market. But as for now, where every conceivable price target for the company in the near future is below it, maybe investors should say the ticker symbol five times fast so they will know what's coming their way. Sanity is contagious and eventually one will understand why this door is marked "short" in swirly red and white lettering.

7. GARDEN FRESH <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LTUS)") else Response.Write("(Nasdaq: LTUS)") end if %> -- Are you starting to believe that this is the thinking investor's FRESH CHOICE <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SALD)") else Response.Write("(Nasdaq: SALD)") end if %>? After June's 20% stock surge there are apparently some believers. Unlike that other troubled purveyor of soup and salad scatter bars, which shares its California home base, Garden Fresh, through its twin concepts called Souplantation and Sweet Tomatoes, has grown a profitable business serving up one-price smorgasbord dining of greens and such odd lot. Garden Fresh earned $0.72 last year (the fiscal year ends in September) and after bearing estimates for the first quarter and nailing them in their fiscal second they are now expected to earn $0.87 this year. The stock now finds itself trading at 11 times next year's earnings estimates of $1.03.

The popularity of the concept is rising, as not only is expansion growing the 50-unit chain, but same store sales have been positive every single quarter for the last three years. That's an amazing stat when you consider the one-price nature of these scatter bars. The problem, and hence our opportunity, is Fresh Choice. When the company went public in 1995 their timing couldn't have been worse. While they got $9 a share, the stock tanked from the open as the upstart San Diego chain was slugged in sympathy with their California peer who found itself closing stores, playing musical chairs in management, and still not able to squeeze out a profit.

Recent weakness in other buffet style restaurants like Buffets and Sizzler have probably cast a dark cloud over the niche, which works in Garden Fresh's favor. Since every other company is reporting dreadful results, few new entrants would even try to enter the minefield. This is important since the casual dining industry continues to crowd more and more restaurants into tighter and tighter places. That is no doubt why they continue to beat estimates as analysts scratch their heads at how this young company can defy gravity as their peers belly flop into the sea. While Garden Fresh in now at all-time highs, the tide is still, relatively speaking, quite low.

Book value is now up to $6.60 a share, which finds the company to be a shiny diamond as a profitable restaurant company trading at less than two times book. With expected growth just above 20% annually that is well above their p/e multiple.

So, you've probably already figured that LTUS is short for lettuce... and maybe by now you have also figured that to an investor, lettuce is green.

8. KOO KOO ROO <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KKRO)") else Response.Write("(Nasdaq: KKRO)") end if %> *** SHORT *** - Contrarian bulls can sleep easier tonight. This is the first month since inception that we toss out two short picks for the same month. This time, it's not that we're chicken over the stock market. We're just plain chicken over the prospects of this chicken chain. By now you have probably bored of the BOSTON CHICKEN <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BOST)") else Response.Write("(Nasdaq: BOST)") end if %> burnout, Kenny Rogers Roasters having to back out of Canada, POLLO TROPICAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: POYO)") else Response.Write("(Nasdaq: POYO)") end if %> being battered last year backing out of the continent altogether, KFC weigning down the sluggish PEPSI <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %> restaurant sector soon to be spun-off and the bankruptcies of Clucker's and Pudgies.

In short, things have been rough for the chicken chains that have made money. Enter Koo Koo Roo. It's a company known more for the revolving door of noteworthy directors (Michael Milken, Lee Iaccoca) than for their high-end rotisserie concept. With the majority of their units in California, and smaller presences in another half-dozen markets, I'll admit the place is impressive.

They offer a wide array of salads, tossed-to-order, some decent side dishes and a skinless chicken product that is healthy and a bit flavorful. The problem is that they are more labor intensive than your basic Boston Market operation while incurring higher food costs. It's a double curse which has the company having to price their product above their competition.

While that still doesn't scare away too many patrons, unfortunately, it has scared away profits. Earnings seem ever-elusive and since I've kept a distant eye on the company more than two year ago the CFO always seems to eat his words when he expects profitability a few quarters later. Last year it was no longer profitability but simply cash-flow positive. Yes, EBITDA, which the company is still negative on, but the revised hope is for that to change by the end of this year.

Now that's certainly better than nothing. At least cash flow positive will mean the current units won't be draining the company of cash but in a fickle world where P/E's matter, and to get there you need earnings, not just profits before you account for interest expense, depreciation and amortization, things continue to look bleak.

The thing is they don't show up. These profits, maybe, they're, well, chicken. So the company loses money and has to offer private placements to receive money to keep running and growing. Shares outstanding will now bloat to 25 million shares after the recent announced offering.

Two years ago at this time there were 10 million shares outstanding. Last year it was just below 15 million. So back in those years, when the stock peaked at $10 a share, the market cap was actually lower than where it is today, with the stock at $6 1/2. With no improvement in the fundamentals, and no new marquee directors to drum up investor support.

Their insistence of using stock as legal tender is frightening. It has also meant ill-advised acquistions like do-it-yourself ceramic haven Color Me Mine and the once bankrupt Hamburger Hamlet. Color Me Mine has proven to be a disaster as its financial attraction has faded as quickly as the ratings of NBC's "Friends". Being the highest bidder on Hamburger Hamlet also showed a lack of direction.

They bought the chain because they planned to keep the cash-flow positive units. For a company struggling with that very same problem the logic was flawed. A money market account is cash flow positive as well. The problem is that the company may very well come to see profitability, like every other chicken chain that hasn't folded, but how many shares will be outstanding then. And if so, will the profit divided by x million shares be anything significant to justify its share price?

Koo Koo Roo is the sound a rooster makes when it wakes up in morning. Maybe shareholders can use a good wake-up call too.

The June Edible Eight

Company                           Price (6/26/97)
Rainforest Cafe <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RAIN)") else Response.Write("(Nasdaq: RAIN)") end if %>         25 3/4
Apple South <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: APSO)") else Response.Write("(Nasdaq: APSO)") end if %>             14 1/8
Rock Bottom Rest. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BREW)") else Response.Write("(Nasdaq: BREW)") end if %>        9 3/4
Bertucci's <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BERT)") else Response.Write("(Nasdaq: BERT)") end if %>               6 7/8
Quality Dining <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QDIN)") else Response.Write("(Nasdaq: QDIN)") end if %>           4 7/8
Coca Cola <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KO)") else Response.Write("(NYSE: KO)") end if %> ***short***       69 7/8    
Garden Fresh <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: LTUS)") else Response.Write("(Nasdaq: LTUS)") end if %>            11 7/8
Koo Koo Roo <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KKRO)") else Response.Write("(Nasdaq: KKRO)") end if %> ***short***  6 1/2 

Until next week, Digest Foolishly,
MF Edible

Check Out The Food & Restaurants Message Board

© Copyright 1995-2000, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. The Motley Fool is a registered trademark and the "Fool" logo is a trademark of The Motley Fool, Inc. Contact Us